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3 Stocks to Win Amid Brazil's Slump

A sluggish economy and persistently high inflation have combined to curb venture capital firms’ appetite in Brazil. The once-popular investment hub for private equity and venture capital firms had to lose out to other Latin American counterparts like Mexico, Colombia and Peru as investors turned to more nascent markets for higher return on investments.

From being the cynosure of the Latin American market with 79% of the regional fundraising in 2011 and $8.1 billion capital raised for investments in the country, Brazil has since slumped. The tallies have declined to 65% and $3.6 billion in 2012 and further to 42% and $2.3 billion in 2013, respectively.

After luring investors with a lucrative 7.5% GDP growth in 2010, when the global economy was trying to emerge out of the financial crisis, Brazil seems to have run out of steam as the primary growth drivers of consumer spending and industrial production steadily went on a downhill. According to the Brazilian central bank’s IBC-Br index of economic activity, a preliminary indicator of GDP growth, the economy shrank 0.2% in the fourth quarter of 2013. This followed a contraction by the same magnitude in the preceding quarter, probably entering into a technical recession.

The U.S. Federal Reserve’s decision to taper its monthly bond-buying program to $65 billion might have also added to the woes of this emerging economy. Approximately $12 billion has reportedly been taken out of emerging stock markets so far this year. The country that was once synonymous with the five major emerging national economies in BRICS (Brazil, Russia, India, China and South Africa) is now being associated with Fragile Five (Turkey, Brazil, India, South Africa and Indonesia). This highlights the risk of economies that have become overtly reliant on skittish foreign investments to finance their growth ambitions.

Despite this pessimism, Brazil still possesses some potential stocks in this highly volatile equity market. Before we zero-in on these profitable picks, let us take a stock of the current situation.

The Rise of Private Equity and Venture Capital in Brazil

At a time when the global economy was plagued by a financial crisis, Brazil evolved as the darling of the investor community with an expanding economy and a rising middle class population. About 29 million people were estimated to be added to the Class C segment of the economy between 2003 and 2009, which exceeded the cumulative purchasing powers of Class A and Class B segments.

These increased consumption in various segments, ranging from basic goods such as food products and healthcare to discretionary goods such as personal care. With radical socio-economic transformations and sustainable development initiatives, the country attracted global investors to this burgeoning sector as consumer spending accounted for over 60% of GDP.

Consequently, the private equity and venture capital industry in Brazil boomed over the years and raised $4.8 billion of capital in 2009, up from $2.3 billion in 2005. The advent of private equity transactions also benefited from a broader selection of investment opportunities and lesser regulatory controls, making it one of the easier places to park their money.

Brazil also had the advantage of being a consolidated democracy and shared cultural affinities with the U.S. and Europe. A 2010 secondary offering worth R$120 billion by Petrobras Argentina SA (PZE - Free Report) further catapulted investor confidence and transformed Brazilian stock exchange BM&F BOVESPA into the then second largest stock exchange by market value.

The Ignominious Fall

As Brazil’s growth model primarily hinged on the export of basic commodities and raw materials, the challenging global macroeconomic environment dent a severe blow to its economy and the country seemed to miss a backup plan to up the ante. GDP growth plummeted from close to high mid-single digits to abysmally low in the later half of 2013, contracting 0.2% in the fourth quarter. Consequently, the country’s appetite for venture capital and private equity was slowly on a wane.

On top of it, higher inflation dealt a knock-out blow, depressed business and consumer confidence and swelled manufacturing costs. A series of interest cuts by the central bank of the country since April last year, to keep price rises at bay, has failed. Inflation stood fairly high at 5.6% in Jan 2014, significantly higher than the official target of 4.5%.

In addition, Brazil is slated to host the World Cup soccer in 2014 and the Summer Olympics in 2016. Although both the events are likely to attract more revenues from advertising and tourism, it requires a significant upfront investment from the country to build the infrastructure facilities. Unless the events earn decent revenues for the national exchequer, use of public funds for populist extravaganza is sure to create a huge furor in the country.

The Fed tapering further witnessed a high exodus of foreign capital, as investors began to divert funds back to the U.S. in search of higher returns. Undue reliance on overseas investments to ward off large current account deficits and looming domestic elections have jeopardized the sovereign rating of the country. Credit rating agencies like Moody’s have warned of an additional downgrade from its Baa2 rating.

3 Promising Brazilian Stocks

Despite the hoopla surrounding the country, the Brazilian equity basket holds certain stocks that look attractive in terms of valuation and sport solid Zacks Rank. Let’s take a closer look at these companies that appear to be well positioned to benefit from their solid sector dynamics.

Companhia de Saneamento Basico do Estado de Sao Paulo (SBS - Free Report) : Headquartered in Sao Paulo, Brazil, this Zacks Rank #1 (Strong Buy) stock offers basic and environmental sanitation services in the region. The company also supplies treated water to residential, commercial, industrial and municipal customers and operates 214 water treatment stations and 502 sewage treatment stations. This utility stock is currently trading at an eye-catching forward P/E of 7.4x.

Ultrapar Holdings Inc. (UGP - Free Report) : Since its inception in 1937, this Zacks Rank #2 (Buy) stock is engaged in the fuel distribution and chemical businesses in Brazil. Headquartered in Sao Paulo, Brazil, the company offers bulk liquefied petroleum gas, diesel, gasoline, ethanol and natural gas. In addition, the company also markets various chemicals such as ethylene oxide, ethylene glycols, ethanolamines, glycol ethers, ethoxylates, solvents, fatty acids from vegetable oils, fatty alcohols and specialty chemicals. The company also operates in Mexico, Venezuela, Uruguay, and the U.S. This basic materials stock is currently trading at a decent forward P/E of 20.2x.

CPFL Energia S.A. : CPFL Energia offers electricity in Brazil, generating energy through hydroelectric, thermoelectric, sugarcane biomass, solar energy, and wind power plants. The company distributes electricity to approximately 7.2 million consumers primarily in the states of São Paulo and Rio Grande do Sul. Headquartered in Sao Paulo, Brazil, this Zacks Rank #2 (Buy) stock is currently trading at an attractive forward P/E of 12.4x.

Don’t Miss These Golden Geese

As the country remains focused to stay afloat amid a deteriorating macroeconomic scenario and uncertainty ahead of presidential elections in October, this is probably the most opportune time to own some high-potential Brazilian stocks with strong fundamentals that pledge a healthy ROI.

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